A blog of the NYU Colloquium on Market Institutions and the Leipzig Colloquium on the Market Order

Why Not A Big Tax Cut?

We have an exact measure of the most recent recognition lag. This month the National Bureau of Economic Research identified the beginning of the current recession as December 2007. So the lag is about a year. Click for NBERYou’ll recall that in the 1950s Milton Friedman pointed to the time it takes economists to recognize a recession as one of the lags that reduce the effectiveness of counter-cyclical federal spending. While aiming to stabilize economic activity, such programs cause instability if the recession is already passing. In the 1990s Martin Feldstein argued that counter-cyclical fiscal policy has a role to play in the case of a sustained downturn such as the one that afflicted Japan. Professor Feldstein’s point has obvious relevance for the US. Click for Feldstein comment

But there is another issue. Friedman favored tax cuts rather than expenditure increases if the federal budget has to be used to boost aggregate demand. It may be objected that consumers would not spend enough at a time like this, with confidence at low ebb. But surely that depends on the size and time horizon of the tax break.

The Bush tax rebate was a small one-shot affair, so it had a temporary effect. Why not an across-the-board, two-year cut in the federal income tax, retroactive to December 2007? Make it 20% or more, and I know it would change my perspective as a consumer.

That’s fine with me as long as there’s also an exemption for women named Chidem Kurdas. I suspect, though, that giving it to some people will be an open invitation for intense lobbying by other groups–consider the line for bailouts.